Policy Brief Examines ‘Public Option’ Debate

A new policy brief from Health Affairs and the Robert Wood Johnson Foundation explores a key aspect of landmark health reform legislation passed by the House of Representatives: the proposal for a government-run public health insurance plan. The brief lays out details of the plan, including who could enroll, who could receive subsidies to buy coverage, and the anticipated impact on health insurance premiums.

The brief also describes pros and cons of the House proposal, such as why public plan supporters think it is necessary and why critics believe the idea will backfire. Supporters say that a public plan would offer more affordable coverage, could stimulate competition, and could lead the way in improving the entire health insurance market. Those opposed question the public plan’s ultimate financial stability and are concerned that despite legislative language to the contrary, taxpayers may some day have to bail it out.

This Health Policy Brief updates an earlier brief about the public plan that was originally published in June 2009. Subsequent policy briefs will explore another version of the public plan expected to emerge in legislation in the Senate, as well as any changes to the House version over time.

The free Health Policy Briefs are geared to policymakers, congressional staff, news media, and other readers who may not have a background in health issues but want to better understand the basics of proposed changes in the nation’s health care system. The briefs provide jargon-free overviews that include arguments from competing sides of a policy proposal and the relevant research supporting each perspective.

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Health Policy Briefs offer more context than fact sheets and are more digestible than most backgrounder papers. The information is objective and reviewed by Health Affairs authors and other specialists with years of expertise in health policy.

1 Response to “Policy Brief Examines ‘Public Option’ Debate”

Central to health care (finance) reform is the correction of common myths about risk and insurance. There are approximately 1,300+ health benefit companies operating in the USA. A common misconception is that all these “insurers” face identical risks, identical opportunities for profitability, identical probabilities of net operating gains, and identical probabilities of insolvency or avoidance of insolvency regardless of the number of policyholders the insurer covers. None of these assumptions are true.

As well, when “innovative” cost control mechanisms are used, such as capitation, episode based care, or DRGs payments schemes, these mechanisms transfer “insurable” risks to health care providers. While some prefer to characterize such risks as performance and/or inefficiency risks, they are quite clearly exchanges of liabilities for uncertain costs in lieu of fixed payments – the classical definition of an insurance risk transfer.

Fortunately, we can characterize the impact of insurer size on operating characteristics fairly easily. While complex models of insurer risk, beginning with models for individuals and building toward aggregate risks are the usual route preferred by actuaries, these models are unduly complex, offer little insight accessible to the general public and policymakers, and become obstacles to understanding risk and insurance rather than highways. We can, using the insight that the Central Limit Theorem provides information about the impact of insurer size on loss ratio variation, compare the operating characteristics of insurers.

I call this form of analysis “Professional Caregiver Insurance Risk.” Interested readers can look at any introductory statistics book for explanations of the mean, variance, standard deviation, and standard error the critical concepts that underlie this manner of comparing the effect of size on insurer operating results.

PI earns profits of at least 5% at or below loss ratios of $0.80, occurring with probability 0.8413. PI avoids operating losses (LR < $0.85) with probability 0.9772. PI can withstand extreme losses, the essence of insurance, if it sets aside liquid assets, called "Surplus," sufficient to cushion it from a single year loss ratio of $0.90, which protects PI from insolvency with probability 0.9987 (Protection against a loss ratio occurring with probability 0.0013). PI will become insolvent if its loss ratio exceeds 0.90. PI's surplus requirement is 5% (0.90 – 0.85) of its gross premium revenues.

A true national insurer (NI), with 307,000,000 policies would have a size adjusted standard error of 0.0029 compared with PI's 0.05. For identical premium charges, NI would have a probability of profits of at least 5% 0f 1.0000. NI's probability of avoiding net operating losses would be 1.0000. NI would not, because it has such a small standard error, require any surplus to protect itself from a loss ratio occurring with probability 0.0013. NI could provide benefits of $0.7971 per dollar of premium collected.

A small insurer SI [readers are encouraged to make the leap to risk assuming health care provider] insuring 100,000 policyholders has dramatically different probabilities of these same operating characteristics. SI's probability of profits of at least 5% is just 0.6241 because SI's standard error is 0.1581 rather than PI's 0.05. SI avoids operating losses with probability 0.7365 and SI should protect against a loss ratio occurring with probability 0.0013 by maintaining surplus adequate to cover a single year loss ratio of 1.2261.

Small insurers manage risk so inefficiently that they cannot provide benefits anywhere near those achievable by NI. PI, for example, can provide maximum sustainable benefits of $0.75 per dollar of premium and meet the performance goals above. SI, on the other hand, can only provide benefits of $0.6419 per premium dollar. The difference between NI's benefit levels ($0.7971) and SI's benefit levels are solely due to inefficient risk management operations, based solely on portfolio size.

We must lay aside the myth that all insurers face the same operating characteristics if we are not going to continue a specious debate. The erroneous assumption that private insurance markets are more efficient than a national health insurance program can be refuted by a reasonably bright high school student and our public policy debate ought to be at least this informed.